DBRS Comments on U.S. Bancorp’s 3Q12 Earnings – Senior at AA Unchanged

DBRS, Inc. (DBRS) has today commented that the ratings of U.S. Bancorp (USB or the Company), including its Issuer & Senior Debt rating of AA, are unchanged following the release of the Company’s 3Q12 earnings. The trend on all ratings remains Stable. For the quarter, USB reported record net income of $1.5 billion, 4.2% higher than 2Q12 and 15.8% higher than 3Q11.

In DBRS’s view, USB’s solid third quarter results highlight the strength of the Company’s franchise, and continue to support its high rating level. Despite the difficult operating environment, USB was able to grow revenues and income before provisions and taxes (IBPT) on a YoY and linked quarter basis. The Company continues to generate returns, including an ROE of 16.5% in 3Q12, which differentiates it from nearly all of its competitors. At the same time, capital remains solid, funding remains robust, and credit continues to improve.

Specifically, revenues, which are well-diversified by product and split 54%/46% between spread and fee income in 3Q12, increased 2.2% from 2Q12 to $5.2 billion and IBPT was up 4.2% QoQ to $2.6 billion. Benefiting from another strong mortgage banking quarter as well as higher service charges on deposits, noninterest income totaled $2.4 billion for 3Q12, up 1.7% from 2Q12. Meanwhile, net interest income increased 2.6% from the second quarter to $2.8 billion. USB was also able to generate positive QoQ operating leverage in the third quarter as the growth in revenues outpaced a modest 0.3% rise in operating expenses. As a result, the efficiency ratio improved 70 bps from 1Q12 to 50.4%.

Third quarter results also evidenced positive underlying balance sheet trends. Average loans increased 1.3% in the quarter, and were up 1.6% QoQ (excluding the sale of a card portfolio). Growth again was driven primarily by C&I lending, where average balances increased 3.6% QoQ to $62.2 billion. USB also added some mortgage loans to the portfolio in the quarter (average balances up $1.8 billion), which DBRS notes were primarily 15-year, branch-originated Mortgage Refi.’s with very low credit risk. In line with prior guidance, the average securities portfolio of $72.5 billion was maintained at around 2Q12 levels, but up 9% from 3Q11. Assuming stable cash balances and current Basel III liquidity requirements, the Company expects to maintain the securities portfolio at current levels for the next few quarters. DBRS believes that this will likely result in modest net interest margin (NIM) pressure in the coming quarters given the very low reinvestment rates, though the NIM is not expected to decline by more than a few basis points in 4Q12.

In the third quarter, however, USB was able to offset a 10 bps decline in average asset yields thanks to the roll-off of about $6 billion of higher cost debt. This, and notable 5.6% growth in average noninterest-bearing deposits, resulted in a modest NIM expansion of one basis point from 2Q12 to 3.59%. DBRS notes that average total deposits grew 3.5% QoQ to $239.3 billion.

Credit continues to improve at USB, evidenced by further improvement in most key credit metrics. Excluding charge-offs of $54 million related to the new OCC guidance for consumer loans where the borrower has gone through a Chapter 7 bankruptcy, total net charge offs (NCOs) of $484 million declined $36 million QoQ and were 0.89% of total average loans; below what the Company sees as its normalized range of 1.0% annually. Nonperforming assets, excluding covered assets as well as $109 million of nonperformers related to the new OCC guidance, fell 7.8% from 2Q12, to $2.1 billion. Accruing 90+ day delinquencies (excluding covered loans) were $644 million, down slightly from the end of 2Q12. Given current trends, USB released $50 million of reserves in the quarter, the same as last quarter. In DBRS’s view, USB’s $4.8 billion allowance for credit losses continues to provide solid coverage. At September 30, reserves covered 213% of nonperforming assets (ex-covered loans) and were 2.19% of total loans.

USB’s financial fundamentals and capital position remain sound and support the Company’s rating levels and Stable trend. DBRS sees USB as less impacted by Basel III than larger U.S. banks given its limited capital markets activities and its comparatively smaller mortgage servicing business. Evidencing this contained impact, the Company’s estimated Basel III Tier 1 Common ratio (on a fully implemented basis) was 8.2%, up 30 bps QoQ and only 80 bps below its Basel I Tier 1 common ratio of 9.0%. DBRS views USB’s current capital levels as continuing to provide substantial loss absorption capacity given its moderate risk profile and strong organic capital generation capacity.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the
purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 4 April 2005
Most Recent Rating Update: 6 July 2011

For additional information on this rating, please refer to the linking document under Related Research.